The RIA channel of the advisory business is soaring, recording its highest-ever median profit margin in 2014. But will it heed warnings that talent shortages and outdated compensation methods could send it into a tailspin?

The latest data on the wealth management industry’s performance comes from the new FA Insight Study of Advisory Firms: People and Pay. The 50-page report is prepared by FA Insight, a research and consulting firm, and spotlights trends in firm performance, advisor productivity and compensation.

Overall, the report notes, 2014 was a banner year. Rising productivity, improved operational efficiencies driven by technology, growing demand for holistic financial planning and, to be sure, the long-running bull market have produced a period of unprecedented prosperity for advisors.

But there is cautionary data in the FA Insight study as well. “There is no guarantee that the good times will continue,” admonishes Dan Inveen, an FA Insight principal and its director of research. “My greatest concern is that firms are living on borrowed time when it comes to their personnel. The typical advisor is aging and nearing retirement. With experienced labor in short supply, how much longer can firm productivity increase without commensurate increases in compensation?”

THE COMPENSATION PARADOX

As it happens, compensation has been increasing steadily across a variety of industry positions.

Chief operating officers, for example, have received a 7% compound annual growth rate in pay since 2009, while office managers’ compensation have risen 4%. The gains have been driven by the industry’s growth. As the study notes: “The typical firm is now at a size where the COO position and dedicated management in general, have become critical for firm success.”

Yet revenue per RIA professional jumped even more. The median revenue per professional was $528,500 last year, a whopping 31% increase from the $363,600 generated in 2009. And with productivity rising faster than compensation, the industry is seeing increasingly higher profits.

But these gains haven’t been evenly distributed and, paradoxically, those firms that are paying more for talent are also the most profitable. What FA Insights terms “standout firms,” which rank in the top 25% of revenue growth and income generation, pay more for talent but gain greater productivity because their advisors and other personnel generate more revenue per professional than their peers. For example, in 2014 top advisors at standout firms generated $867,472 per professional, compared with $754,049 for their peers at other firms.

Standout firms, the study notes, “clearly define their organizational structures for a blueprint that can better accommodate hiring and growth.” And larger standout firms are “more prone to use performance-based incentive pay to better motivate team members.”

Using incentive-based pay for advisors, as well as management and technical positions, is especially valuable, the study concludes, because of the “greater ability” of the people in those jobs to “influence firm success.” And as standout firms grow larger, results from the study indicate, “performance-based pay becomes even more integral to success.”Among all the advisory firms surveyed, however, just 33% reward professionals exclusively through performance-based incentives.

IN IT TOGETHER

Those who are using incentives endorse the process enthusiastically. Savant Capital Management in Rockford, Ill., has a companywide bonus program dubbed Team Savant, where everyone from the CEO to administrative staff is tied to the same metrics: the firm’s revenue, profit and AUM growth. If the growth metrics reach the 15% target, employees receive a full bonus. If growth exceeds 15%, a larger bonus is paid; if growth comes in at 10%, employees get two-thirds of their potential bonus.

The program is part of a shift at Savant away from a base salary compensation model to a hybrid model that combines base and incentive pay. “Everybody’s in it together,” says Savant CEO Brent Brodeski. “We’ve been very pleased.”

The incentive program has a big advantage on the downside as well. More variable compensation means lower fixed costs, putting the firm in a better position to absorb a drop in revenue, should this occur. If most labor costs were fixed, Brodeski points out, a decline in assets would “come right off the bottom line.”

Likewise, advisor compensation at FJY Financial of Reston, Va., includes base pay, individual incentives and firm incentives “from Day 1,” says Jon Yankee, partner and chief executive. Criteria for receiving additional compensation include securing new referrals for the firm and generating more revenue from existing clients.

Equity is also a powerful incentive, the study notes, and Yonhee Gordon, principal and chief operating officer of JMG Financial Group in Oak Brook, Ill., agrees. “We have 13 owners, and they are all employees,” Gordon explains. “Criteria for an equity stake include performance, leadership, revenue they bring in and business development. We have semiannual evaluations, and employees who are on track for an equity stake are voted in by the current owners.”

“Don’t underestimate the power of performance-based pay to align work behavior with firm strategy,” Inveen says. “The key is to set the right balance in linking incentives to both individual and firm related objectives. This will ensure that individual effort complements, rather than conflicts with firm goals.”

Brodeski agrees. “The balancing act is an art, not a science,” he says. “If compensation is too formulaic, you can’t reward your real rock stars, and your top performers will leave. But if it’s too discretionary and personalized, it can become all about me and not the firm, and that’s not good.”

Technology plays a role as well. New software helped FJY to reduce its overhead. “What once took us an hour now takes about five to 10 minutes,” Yankee says. “That’s a significant enhancement. As a result, instead of having to pay for back-office staff, we can hire more client-facing advisors.”

Dearth of Talent

But before they can motivate them with incentives, advisory firms also need to ensure that they can recruit top talent in the first place. According to Inveen, aging owners say the shortage of qualified personnel to meet the burgeoning demand for talent poses the “biggest threat” to advisors’ current good fortune.

As Brodeski puts it, “it’s really difficult to find experienced advisory help. Top quality people are not on street corners handing out résumés. They’re usually already happy where they are.”

In response, advisors place great stress on the hiring process. “We want to make sure there are no surprises about what the job is,” says JMG’s Gordon. “We give candidates assessments to convey what the job is like. For example, we will give them a timed assignment that is related to the job they will be doing. Their answers or solutions don’t have to be correct, but we want to see how they think and how they got to the answer.”

Inveen agrees that advisors are moving “in the right direction” when it comes to their hiring practices. “We see that RIAs are being weaned away from their longstanding reliance on hiring experienced advisors, and focusing more on a new generation,” he says.

Just four years ago, more firms looked to other RIAs for new talent than any other source, the study reports. But this year, less than one-third of the firms surveyed are turning to other RIAs for new talent and the share of firms targeting wirehouses as a primary source of new hires dropped by more than half.

Instead, firms are now “more likely to look at recent college graduates than any other source,” according to the study. FJY Financial is a case in point. CEO Yankee says it works closely with a number of schools with financial planning graduate programs to recruit interns and new hires.

“We’ve had great success and have hired great people,” Yankee says. “We’ve developed a good internship program that emphasizes high touch with clients, and I think that’s helped us establish a reputation as a place where young people who are really serious about a long-term career want to go.”

The short supply of labor outstripped by demand is “one of the biggest clouds on the horizon” for advisory firms, agrees Jessica Maldonado, vice president for Searcy Financial Services in Overland Park, Kan.

To introduce college students to the industry, Maldonado works with a number of schools, including Kansas State University and the University of Missouri at Kansas City, to supply its internship program. “Even if we don’t get immediate productivity,” she says, “we’re planting the seeds for a future harvest.”

As for new recruits, Maldonado says she hires people more for their attitude than their experience. “Three of our last five hires have been students just out of college,” she reports. “I’m interested in the right kind of person who is a good cultural fit. I can teach them the business.                    


Charles Paikert is a senior editor of Financial Planning. Follow him on Twitter at @Paikert.

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